The Wall Street Journal
With Bear Assets, Fed Balances Preserving Investment and Helping Borrowers
James Currell is struggling to prevent his Minnesota home from being foreclosed. But his lender isn't a bank. It is the U.S. government.
The Federal Reserve Bank of New York is facing the prospect of foreclosing on a number of properties in the coming months, from homes to commercial buildings, a result of a souring mortgage portfolio it took over when it helped bail out Bear Stearns in 2008.
As it deals with delinquent borrowers, a team of New York Fed officials and outside advisers are trying to avoid having the U.S. government, along with local sheriff's departments, seize commercial properties and homes as it copes with falling real-estate values. In the process, the New York Fed is getting a hard lesson in the challenges of mortgage lending.
It is an unprecedented test for the most powerful of 12 regional branches of the Federal Reserve System. In its 96-year history, the Fed hasn't made or controlled loans to U.S. citizens and businesses outside of banking since the 1930s, when it was done on a much smaller scale. Now, under the watchful eye of Congress, the New York Fed must recoup a $29 billion loan secured by the Bear assets.
"For the Fed to come in and foreclose on properties puts it at some reputational and political risk," said Vincent Reinhart, a former senior Fed staffer who is now an economist at the American Enterprise Institute. "If the Fed can't figure out how to recast the terms of these mortgages and work with borrowers—it's emblematic of the problems the government has had with other programs over the last year and a half," he added.
The New York Fed faces certain unique issues. It is trying to avoid selling problem assets at discounted prices, which could disrupt markets and hurt banks. And while the regulator is open to modifying existing commercial-property loans, it is less likely than some banks to restructure a loan in a joint-venture situation if it meant the New York Fed couldn't call the shots in a restructuring.
The New York Fed's stance about how to pursue foreclosures is a sensitive balancing act. If it proceeds with numerous foreclosure proceedings in the coming months, particularly on residential mortgages, it could trigger concern among legislators looking to protect homeowners in their districts. The issue is particularly sensitive because taxpayers helped fund the Bear Stearns bailout.
As a lender, the regulator is "a pretty tough negotiator," Helen Mucciolo, a career New York Fed official, said in a recent interview, adding that there is no one-size-fits-all approach to working out each loan as her team seeks to maximize value for U.S. taxpayers.
Overall, the portfolio that acquired the Bear assets for $30 billion in March 2008 had a value of $29.4 billion as of June 30, 2010. The portfolio's value had dropped to about $25 billion during the depths of the financial crisis.
The problem spot is the real-estate holdings. The portfolio's residential and commercial loans were worth about $5 billion recently, compared with $9.6 billion in March 2008, when Bear Stearns collapsed, illustrating the financial pain other U.S. banks are experiencing as they deal with their own souring holdings of home loans, offices, hotels, shopping centers and land. So far, buyers have been found for about $1 billion in commercial loans.
The New York Fed's holdings of commercial-real-estate debt lost 35% of their value over the two years ended March 2010, while a pool of residential loans fell about 60%, according to New York Fed documents and people familiar with the matter.
So far, the regional Fed bank and a company it financed called Maiden Lane LLC have foreclosed on only one commercial property, an Oklahoma City mall it has put up for sale. More commercial foreclosures are expected, a person familiar with the situation says.
Maiden Lane also has been forced to foreclose on homes in California, Illinois, Georgia and Washington, according to public foreclosure records. In addition to working out loans, the New York Fed's team, led by Ms. Mucciolo, is trying to exit from Bear's old trading positions tied to scores of mortgage securities and derivative contracts.
The New York Fed ended up with the portfolio as part of the bailout of Bear Stearns, the Wall Street firm that collapsed amid a cash crunch, an early sign of the 2008 market panic. In the bailout, J.P. Morgan Chase & Co. bought Bear Stearns but didn't want to take $30 billion of its assets, its portfolio of real-estate loans and securities.
To facilitate the deal, the New York Fed set up Maiden Lane as a Delaware corporation and extended to the enterprise a 10-year, $29 billion loan so it could take control of the orphaned Bear assets, which were pledged as collateral for the emergency loan. Now, the New York Fed is trying to unwind the portfolio to recoup the loan. J.P. Morgan put up roughly $1 billion to finance Maiden Lane and will be repaid only after the New York Fed recovers its money.
The Federal Reserve Bank of New York is facing the prospect of foreclosing on a number of properties in the coming months, from homes to commercial buildings, a result of a souring mortgage portfolio it took over when it helped bail out Bear Stearns in 2008.
As it deals with delinquent borrowers, a team of New York Fed officials and outside advisers are trying to avoid having the U.S. government, along with local sheriff's departments, seize commercial properties and homes as it copes with falling real-estate values. In the process, the New York Fed is getting a hard lesson in the challenges of mortgage lending.
It is an unprecedented test for the most powerful of 12 regional branches of the Federal Reserve System. In its 96-year history, the Fed hasn't made or controlled loans to U.S. citizens and businesses outside of banking since the 1930s, when it was done on a much smaller scale. Now, under the watchful eye of Congress, the New York Fed must recoup a $29 billion loan secured by the Bear assets.
"For the Fed to come in and foreclose on properties puts it at some reputational and political risk," said Vincent Reinhart, a former senior Fed staffer who is now an economist at the American Enterprise Institute. "If the Fed can't figure out how to recast the terms of these mortgages and work with borrowers—it's emblematic of the problems the government has had with other programs over the last year and a half," he added.
The New York Fed faces certain unique issues. It is trying to avoid selling problem assets at discounted prices, which could disrupt markets and hurt banks. And while the regulator is open to modifying existing commercial-property loans, it is less likely than some banks to restructure a loan in a joint-venture situation if it meant the New York Fed couldn't call the shots in a restructuring.
The New York Fed's stance about how to pursue foreclosures is a sensitive balancing act. If it proceeds with numerous foreclosure proceedings in the coming months, particularly on residential mortgages, it could trigger concern among legislators looking to protect homeowners in their districts. The issue is particularly sensitive because taxpayers helped fund the Bear Stearns bailout.
As a lender, the regulator is "a pretty tough negotiator," Helen Mucciolo, a career New York Fed official, said in a recent interview, adding that there is no one-size-fits-all approach to working out each loan as her team seeks to maximize value for U.S. taxpayers.
Overall, the portfolio that acquired the Bear assets for $30 billion in March 2008 had a value of $29.4 billion as of June 30, 2010. The portfolio's value had dropped to about $25 billion during the depths of the financial crisis.
The problem spot is the real-estate holdings. The portfolio's residential and commercial loans were worth about $5 billion recently, compared with $9.6 billion in March 2008, when Bear Stearns collapsed, illustrating the financial pain other U.S. banks are experiencing as they deal with their own souring holdings of home loans, offices, hotels, shopping centers and land. So far, buyers have been found for about $1 billion in commercial loans.
The New York Fed's holdings of commercial-real-estate debt lost 35% of their value over the two years ended March 2010, while a pool of residential loans fell about 60%, according to New York Fed documents and people familiar with the matter.
So far, the regional Fed bank and a company it financed called Maiden Lane LLC have foreclosed on only one commercial property, an Oklahoma City mall it has put up for sale. More commercial foreclosures are expected, a person familiar with the situation says.
Maiden Lane also has been forced to foreclose on homes in California, Illinois, Georgia and Washington, according to public foreclosure records. In addition to working out loans, the New York Fed's team, led by Ms. Mucciolo, is trying to exit from Bear's old trading positions tied to scores of mortgage securities and derivative contracts.
The New York Fed ended up with the portfolio as part of the bailout of Bear Stearns, the Wall Street firm that collapsed amid a cash crunch, an early sign of the 2008 market panic. In the bailout, J.P. Morgan Chase & Co. bought Bear Stearns but didn't want to take $30 billion of its assets, its portfolio of real-estate loans and securities.
To facilitate the deal, the New York Fed set up Maiden Lane as a Delaware corporation and extended to the enterprise a 10-year, $29 billion loan so it could take control of the orphaned Bear assets, which were pledged as collateral for the emergency loan. Now, the New York Fed is trying to unwind the portfolio to recoup the loan. J.P. Morgan put up roughly $1 billion to finance Maiden Lane and will be repaid only after the New York Fed recovers its money.
It could take years. In mid-July, Maiden Lane made its first monthly principal repayment: a relatively modest $30 million.
A 22-person team at the New York Fed's Investment Support Office is overseeing the portfolio at the central bank's building on a street called Maiden Lane in New York's financial district. The team is headed by Ms. Mucciolo, 44 years old, who joined the regulator in 1993 after receiving a graduate business degree at Pace University.
The New York Fed hired investment firm BlackRock Inc. to manage the Bear portfolio and handle negotiations with borrowers while the regulator has a behind-the-scenes role. BlackRock was paid about $35 million in fees for its work on Maiden Lane last year.
More foreclosures could stick the New York Fed with properties it can't sell. Consider the 2009 foreclosure of the Crossroads Mall in Oklahoma City, a move that put the New York Fed in control of the 36-year-old shopping venue. The mall since 2007 has lost big tenants such as department store Dillard's.
Maiden Lane last year took over the mall at a sheriff's auction, to protect the value of the note it held on the property. But in a sign the regulator is struggling to unload properties, an Oklahoma broker has been unable to find a buyer for the mall, which was put up for sale in September for $24 million. "No one is happy about owning a mall, but we have to manage this responsibly and see what we get back," Ms. Mucciolo said.
The New York Fed has suffered other losses. It has exposure to Extended Stay Inc., a hotel chain that filed for bankruptcy protection last year amid a slump in the lodging business. After an investor consortium bought Extended Stay in an auction, the Fed was forced to mark down its $744 million in mezzanine debt to $0.
The New York Fed and Maiden Lane also took control of roughly 50 commercial real-estate loans tied to hundreds of properties and 9,000 home loans that included both first-lien and second-lien mortgages.
As of year-end 2009, the principal amount due from residential borrowers was $1.5 billion, 49% of which was "nonperforming," or not accruing interest. (At the same time, 13% of the principal amount due from commercial loans was nonperforming.) The residential pool had a fair value of $1.6 billion in March 2008 that fell to $604 million at the end of this March.
To better oversee the home loans and help more borrowers modify loans, the Fed recently replaced the pool's legacy mortgage-service companies, Wells Fargo & Co. and Bear Stearns unit EMC Mortgage Corp., with Nationstar Mortgage LLC, based in the Dallas suburb of Lewisville. "It is in our interest for borrowers who qualify for a loan modification to get the help they need," Ms. Mucciolo said.
Among those under stress is Mr. Currell, a 60-year-old real-estate investor. In 2007, he took out a loan from EMC Mortgage for $420,000 to refinance an existing loan on a four-bedroom home in Woodbury, Minn., initially for himself that he later opted to rent out. That loan today resides in Maiden Lane's portfolio.
Mr. Currell fell behind on payments and this year filed for bankruptcy protection. Mr. Currell and Nationstar haven't been able to strike a loan-modification deal. The upshot: Maiden Lane could end up with a home worth significantly less than the value of the loan. Nationstar has offered to lower his rate, currently 7.875%, to 5.5%. But Mr. Currell said he needs an even lower rate, and an extended mortgage period. "Maybe we can make it work," he says.
"I'm not whining. I'm a big boy," Mr. Currell says. "I took chances."
Maiden Lane now owns a large amount of relatively safe securities guaranteed by government-sponsored mortgage operators Fannie Mae and Freddie Mac. Many were bought over the past two years with cash Maiden Lane received from interest and principal payments on assets in the portfolio, and they have helped make up for some of the value declines from soured assets.
The New York Fed and BlackRock also are trying to unwind scores of derivative contracts, including credit-default swaps that act like insurance against defaults. Bear Stearns, a major Wall Street dealer, traded the credit protection on corporate and municipal bonds and mortgage securities, including ones underpinned by subprime loans and bond insurance companies.
To exit from some of the trades, the New York Fed and BlackRock have had to locate the bonds underlying the swaps and hand them over to trading partners that include large Wall Street investment banks. So far they have unwound over half the contracts Maiden Lane originally took on.
A 22-person team at the New York Fed's Investment Support Office is overseeing the portfolio at the central bank's building on a street called Maiden Lane in New York's financial district. The team is headed by Ms. Mucciolo, 44 years old, who joined the regulator in 1993 after receiving a graduate business degree at Pace University.
The New York Fed hired investment firm BlackRock Inc. to manage the Bear portfolio and handle negotiations with borrowers while the regulator has a behind-the-scenes role. BlackRock was paid about $35 million in fees for its work on Maiden Lane last year.
More foreclosures could stick the New York Fed with properties it can't sell. Consider the 2009 foreclosure of the Crossroads Mall in Oklahoma City, a move that put the New York Fed in control of the 36-year-old shopping venue. The mall since 2007 has lost big tenants such as department store Dillard's.
Maiden Lane last year took over the mall at a sheriff's auction, to protect the value of the note it held on the property. But in a sign the regulator is struggling to unload properties, an Oklahoma broker has been unable to find a buyer for the mall, which was put up for sale in September for $24 million. "No one is happy about owning a mall, but we have to manage this responsibly and see what we get back," Ms. Mucciolo said.
The New York Fed has suffered other losses. It has exposure to Extended Stay Inc., a hotel chain that filed for bankruptcy protection last year amid a slump in the lodging business. After an investor consortium bought Extended Stay in an auction, the Fed was forced to mark down its $744 million in mezzanine debt to $0.
The New York Fed and Maiden Lane also took control of roughly 50 commercial real-estate loans tied to hundreds of properties and 9,000 home loans that included both first-lien and second-lien mortgages.
As of year-end 2009, the principal amount due from residential borrowers was $1.5 billion, 49% of which was "nonperforming," or not accruing interest. (At the same time, 13% of the principal amount due from commercial loans was nonperforming.) The residential pool had a fair value of $1.6 billion in March 2008 that fell to $604 million at the end of this March.
To better oversee the home loans and help more borrowers modify loans, the Fed recently replaced the pool's legacy mortgage-service companies, Wells Fargo & Co. and Bear Stearns unit EMC Mortgage Corp., with Nationstar Mortgage LLC, based in the Dallas suburb of Lewisville. "It is in our interest for borrowers who qualify for a loan modification to get the help they need," Ms. Mucciolo said.
Among those under stress is Mr. Currell, a 60-year-old real-estate investor. In 2007, he took out a loan from EMC Mortgage for $420,000 to refinance an existing loan on a four-bedroom home in Woodbury, Minn., initially for himself that he later opted to rent out. That loan today resides in Maiden Lane's portfolio.
Mr. Currell fell behind on payments and this year filed for bankruptcy protection. Mr. Currell and Nationstar haven't been able to strike a loan-modification deal. The upshot: Maiden Lane could end up with a home worth significantly less than the value of the loan. Nationstar has offered to lower his rate, currently 7.875%, to 5.5%. But Mr. Currell said he needs an even lower rate, and an extended mortgage period. "Maybe we can make it work," he says.
"I'm not whining. I'm a big boy," Mr. Currell says. "I took chances."
Maiden Lane now owns a large amount of relatively safe securities guaranteed by government-sponsored mortgage operators Fannie Mae and Freddie Mac. Many were bought over the past two years with cash Maiden Lane received from interest and principal payments on assets in the portfolio, and they have helped make up for some of the value declines from soured assets.
The New York Fed and BlackRock also are trying to unwind scores of derivative contracts, including credit-default swaps that act like insurance against defaults. Bear Stearns, a major Wall Street dealer, traded the credit protection on corporate and municipal bonds and mortgage securities, including ones underpinned by subprime loans and bond insurance companies.
To exit from some of the trades, the New York Fed and BlackRock have had to locate the bonds underlying the swaps and hand them over to trading partners that include large Wall Street investment banks. So far they have unwound over half the contracts Maiden Lane originally took on.
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